Investing Amid Low Expected Returns

Success in investing is not about predicting the future but about preparing for it with discipline, patience, and a focus on what you can control.

1. Focus on Process, Not Outcomes

Investing in a low-return world requires a shift in mindset. Instead of obsessing over short-term results, investors should prioritize a disciplined process. Outcomes are often influenced by luck, but a strong process ensures consistency and resilience over time. This approach helps investors avoid emotional decisions and stay grounded in their strategy.

The book emphasizes that many investors fall into the trap of chasing past performance or taking excessive risks to replicate previous high returns. This behavior is unsustainable, especially in an environment where returns are expected to be lower. By focusing on process, investors can make decisions based on evidence and long-term goals rather than reacting to market noise.

For example, adopting a systematic approach to asset allocation and diversification can help mitigate risks. This means sticking to a plan even when markets are volatile or tempting opportunities arise. A process-oriented mindset also encourages humility and patience, which are essential traits for navigating uncertain financial landscapes.

Examples

• Investors who diversified during the 2008 financial crisis fared better than those who chased high-risk assets.
• Pension funds that focused on long-term strategies avoided the pitfalls of short-term market timing.
• Warren Buffett’s success is often attributed to his disciplined, process-driven approach to investing.

2. Adjust Expectations in a Low-Return World

The financial landscape has changed, and investors must adapt. With high asset valuations and low yields, the days of double-digit returns are likely behind us. This shift requires recalibrating expectations and embracing more realistic goals.

Many investors continue to expect high returns, leading them to take on unnecessary risks. For instance, they may invest in illiquid assets or speculative ventures in an attempt to maintain past performance. However, this approach often backfires, resulting in significant losses. Instead, the book advises setting achievable targets and focusing on steady, sustainable growth.

Understanding the broader economic context is also important. Low interest rates and sluggish economic growth mean that traditional asset classes like stocks and bonds may not deliver the same returns as before. By acknowledging these realities, investors can make more informed decisions and avoid disappointment.

Examples

• Historical data shows that U.S. stocks earned 6-7% annual returns from 1900 to 2020, but future projections suggest lower returns.
• Real estate investments after 2006 have underperformed compared to earlier decades, reflecting changing market dynamics.
• Negative interest rates in some countries highlight the challenges of earning returns on cash savings.

3. Understand the Role of Asset Classes

Different asset classes behave differently, and understanding their characteristics is key to building a resilient portfolio. The book explores the roles of liquid assets, illiquid assets, and style-based strategies in today’s market.

Liquid assets like stocks and bonds are easy to buy and sell, but their returns may be lower in the current environment. Illiquid assets, such as private equity and real estate, offer the potential for higher returns but come with added risks and challenges. Style-based strategies, including value and momentum investing, provide additional tools for navigating market conditions.

Investors should evaluate the trade-offs between these options and consider how they fit into their overall strategy. For example, while illiquid assets can enhance returns, they may not be suitable for those who need quick access to their funds. Similarly, style-based strategies require careful implementation to avoid overexposure to specific risks.

Examples

• Momentum strategies, which follow market trends, have historically performed well across asset classes.
• Defensive strategies focusing on high-quality stocks have consistently delivered strong returns.
• Illiquid assets like private equity have shown diminishing returns for investments made after 2006.

4. Alpha Is Rare and Fleeting

Alpha, or the ability to outperform the market, is the holy grail of investing. However, the book highlights that true alpha is rare and difficult to sustain. As markets become more efficient, opportunities for excess returns diminish.

Many investors confuse alpha with market-driven returns or alternative risk premia (ARPs). While ARPs can enhance returns, they are not the same as alpha. Identifying genuine alpha requires a deep understanding of market dynamics and a willingness to challenge conventional wisdom.

Active management can still deliver alpha in certain areas, but it’s becoming increasingly rare. Investors should carefully evaluate the performance of fund managers and avoid paying high fees for mediocre results. A balanced approach that combines active and passive strategies may be more effective.

Examples

• Studies show that most active managers fail to consistently outperform their benchmarks.
• Warren Buffett’s alpha has declined over time as markets have become more competitive.
• Alternative risk premia, such as carry strategies, offer additional returns but are not a substitute for alpha.

5. Diversification Is a Powerful Tool

Diversification is one of the most effective ways to manage risk and improve returns. By spreading investments across different asset classes and strategies, investors can reduce the impact of market volatility.

The book explains that diversification works best when combined with leverage, or borrowed money. While this approach may seem risky, it can enhance returns if implemented carefully. However, many investors are hesitant to use leverage due to its complexity and potential downsides.

Global diversification is another important consideration. Investing in international markets can provide exposure to different economic cycles and reduce reliance on a single region. This approach requires careful planning but offers significant benefits over the long term.

Examples

• Global portfolios have historically outperformed domestic-only portfolios in terms of risk-adjusted returns.
• Mean-Variance Optimization (MVO) helps investors align their portfolios with their risk and return preferences.
• Diversified portfolios fared better during the 2008 financial crisis compared to concentrated ones.

6. Avoid Common Investment Mistakes

Investors often fall into bad habits that undermine their success. These include chasing returns, overtrading, and failing to diversify. The book emphasizes the importance of recognizing and avoiding these pitfalls.

Chasing returns is particularly dangerous in a low-return environment. Investors who flock to high-performing assets often end up buying at the peak and selling at the bottom. Overtrading, driven by overconfidence or impatience, can also erode returns through excessive fees and poor timing.

To counter these tendencies, the book recommends adopting a disciplined approach and using tools to stay on track. Reflecting on past decisions and learning from mistakes can also help improve future outcomes.

Examples

• Pension funds that replaced underperforming managers often found the new managers underperformed as well.
• Studies show that overtrading reduces returns for individual investors.
• Behavioral biases, such as loss aversion, lead to poor investment decisions.

7. Patience and Humility Are Key

Successful investing requires patience and humility. The book argues that these traits are more important than ever in today’s challenging environment. Patience allows investors to stay committed to their strategy, while humility helps them recognize their limitations.

Many investors struggle with impatience, leading them to make impulsive decisions. For example, they may sell during a market downturn or chase speculative opportunities. Humility, on the other hand, encourages a realistic assessment of risks and rewards.

By cultivating these qualities, investors can navigate uncertainty with confidence. This mindset also fosters a long-term perspective, which is essential for achieving financial goals.

Examples

• Long-term investors like John Bogle advocate for patience and low-cost index funds.
• Studies show that patient investors outperform those who frequently trade.
• Humility helps investors avoid overconfidence and excessive risk-taking.

8. Leverage Evidence-Based Strategies

The book emphasizes the importance of using evidence-based strategies to guide investment decisions. This means relying on data and research rather than intuition or speculation.

Evidence-based strategies include diversification, strategic asset allocation, and style-based investing. These approaches are grounded in historical performance and have been proven to deliver consistent results over time. By contrast, speculative strategies often lead to disappointment.

Investors should also stay informed about market trends and adapt their strategies as needed. This requires a commitment to continuous learning and a willingness to challenge assumptions.

Examples

• Value investing, based on buying undervalued assets, has delivered strong returns over the long term.
• Momentum strategies, which follow market trends, are supported by extensive research.
• Diversification reduces risk and improves returns, as demonstrated by historical data.

9. Stick to Core Principles

In a world of speculation and uncertainty, sticking to core principles is essential. The book outlines several key principles, including realistic expectations, disciplined decision-making, and effective risk management.

These principles provide a foundation for navigating the complexities of investing. They help investors stay focused on their goals and avoid distractions. By adhering to these principles, investors can build a resilient portfolio that withstands market fluctuations.

The book also highlights the importance of governance and cost-efficiency. Managing expenses and maintaining oversight are critical for long-term success. These practices ensure that resources are used effectively and align with the investor’s objectives.

Examples

• Low-cost index funds outperform high-fee active funds over time.
• Effective governance helps pension funds achieve their goals.
• Risk management strategies protect portfolios during market downturns.

Takeaways

1. Focus on building a disciplined, process-oriented investment strategy and avoid chasing short-term results.
2. Embrace diversification and consider global opportunities to reduce risk and enhance returns.
3. Cultivate patience, humility, and a commitment to evidence-based strategies for long-term success.